Pros and cons

Mixed bag

SOEs are good at infrastructure projects, not so good at innovation

THE HIGH-SPEED train journey from Beijing to Shanghai is a revelation to a visitor used to Britain's dilapidated railway system. Young women in neat red uniforms take pity on a foreigner and guide him to his seat. The train quickly accelerates to its cruising speed of 300km an hour and reaches Shanghai, 1,318km (820 miles) away, in under five hours. The new station there is a festival of sweeping curves.

The feeling of travelling so fast for so long is disconcerting. The countryside whizzes by in a blur, though the ride is impeccably smooth. Even more disconcerting for a Westerner is the feeling that he is being left in the dust. This is no prestige project for the Chinese elite. The queue to get on the train is more like a scrum. The smell of last night's alcohol hangs in the air. For many Chinese people high-speed trains are becoming a normal convenience.

A visit to the headquarters of Russian Railways can feel a bit like a voyage back in time. The guards wear the peaked hats and gruff manners of the Soviet era. A display shows the children of railway workers triumphing in chess and athletics. Vladimir Yakunin, the company's boss, started his career with the KGB. He concedes that his company is a giant of an organisation: it has 1.2m employees, 20,000 stations, 86,000km of track, a network of schools and health clinics and even an equestrian school. He also agrees that the state's influence is all-pervasive. Three white telephones next to his desk provide him with direct access to the Kremlin (he says he has a separate line to his old friend, Mr Putin). He cannot even sell one of the chairs that surround his vast table without the government's permission.

Yet Mr Yakunin is a dynamo of a man who has changed recruitment policies to attract high-flyers, introduced total quality management and brought in Ernst & Young, an international firm of accountants, to audit the books. He also points out that some of the oddities of his company, such as its schools and clinics, have been around for a century and derive from the difficulties of running a railway in the middle of nowhere. There is no such thing as pure capitalism or pure socialism, he argues; only more or less sensible solutions to practical problems.

Not as simple as it looks

State capitalists like to set China's recent successes against America's mounting failures. They add that Uncle Sam was quick to nationalise General Motors when it needed to. Anti-state capitalists argue that Russia is a Potemkin village and China a paper tiger. For instance, China's high-speed rail looked less wonderful last year when 39 people were killed and about 200 injured in a collision in China's eastern Zhejiang province, after which maximum speeds were reduced across the country.

A balanced assessment of state capitalism has to allow for three caveats. The first is that there is no clear dividing line between state-owned and private companies. “Private” champions such as Huawei, the telecoms giant, have repeatedly been given government help. This makes it hard to produce precise calculations about the productivity of the two sectors. Second, ownership is not the only thing in play. Some of the problems, and the successes, of state capitalism have more to do with rapid development than with state ownership. Third, everything depends on context. It is quite possible for state capitalism to work well in some areas (eg, infrastructure) and badly in others (eg, consumer goods). It is also possible for it to boost growth at one stage of development and impede it at another.

State capitalism's most obvious achievements are in infrastructure. China has produced a large number of world infrastructure records, such as the largest hydroelectric project, the Three Gorges dam, and 6,400km of high-speed rail. It has also scattered new airports and railway terminals across the land. Even Russia's more rough-and-ready railway system works pretty well, despite punishing weather.

BCG, a consultancy, argues that this infrastructure boom will continue for some time yet. Over the next 20 years the BRIC countries will account for more than half of the growth in road travel and more than 40% of the growth in air travel. The consultancy also points out that state institutions are well placed to feed this boom. Sovereign-wealth funds are favouring infrastructure projects to avoid the volatility of the stockmarket. Chinese companies are building roads and railways in Africa, power plants and bridges in South-East Asia and schools and bridges in America. In the most recent list of the world's biggest global contractors, compiled by an industry newsletter, Chinese companies held four of the top five positions. China State Construction Engineering Corporation has undertaken more than 5,000 projects in about 100 different countries and earned $22.4 billion in revenues in 2009. China's Sinohydro controls more than half the world's market for building hydro power stations.

State capitalism has also enjoyed some success in tackling second-generation infrastructure problems such as building the information superhighway and mandating higher environmental standards. China's mobile-phone network is the world's largest, yet it suffers from fewer dropped calls or areas with no signal than America's. China has the world's biggest number of internet users, 420m, of whom 364m have broadband. It has also turned itself into a pioneer in some areas of green energy: it is the world's largest exporter of solar panels, for example. Big bets on green technology can easily turn into big mistakes. But generally infrastructure belongs on the positive side of the ledger.

It is quite possible for state capitalism to work well in some areas (eg, infrastructure) and badly in others (eg, consumer goods)

State capitalism has also been successful at producing national champions that can compete globally. Two-thirds of emerging-market companies that made it onto the Fortune 500 list are state-owned, and most of the rest enjoy state largesse of one sort or another. Governments can provide companies with the resources that they need to reach global markets. They can also insist on mergers that produce global giants.

The obsession with national champions can be dangerous: mating two dinosaurs seldom produces a gazelle. But champions have their uses. They can boost national pride, they can ensure that local companies can compete for the best and the brightest with foreign multinationals and they can help emerging countries to establish global standards rather than playing by other people's rules. The Chinese are determined to do this with the growing market for the “internet of things”.

The most interesting argument in favour of state capitalism is that it makes it easier for emerging countries to learn from the rest of the world. National champions are the corporate world's greatest learning machines. To produce them you need to study the best of the breed. And once you have them you can deepen your learning still further—by listing them on foreign exchanges (which introduces you to the world's sharpest bankers and analysts), or by taking over foreign companies (which can provide you with rare expertise). China's Geely International got access to some of the world's most advanced carmaking skills when it took over Volvo for $1.8 billion. Shanghai Electric Group enriched its engineering knowledge by buying Goss International for $1.5 billion and forming joint ventures with Siemens and Mitsubishi. Saudi Basic Industries Corporation has become more cosmopolitan by purchasing companies in dozens of countries.

All this success is producing much I-have-seen-the-future-and-it works euphoria. The bosses of state industries like to argue that they have the best of both worlds—the ability to plan for the future but also to respond to fast-changing consumer tastes. Even outsiders can sound giddy. Ms Xin of CEIBS points out that the best state companies are infinitely better than their predecessors just five years ago. China Mobile, she says, is as good as almost any of its rivals in the West. Edmund Tse, of Booz & Company, argues that the system is much more flexible than it looks at first sight.

In October 2007 China's president, Hu Jintao, unveiled his highest priority for the future at the 17th National Congress of the Communist Party in the Great Hall of the People: improving the country's “capacity for independent innovation”. China had already been working hard at this. The government had invited Western champions such as Microsoft and Google to establish research facilities, instructed domestic champions to be more innovative and poured money into science and technology clusters (Beijing's Zhongguancun Science Park was already home to nearly 20,000 high-tech enterprises as Mr Hu spoke). But it needed to redouble its efforts in the future.

Other state-capitalist countries are equally keen on independent innovation. The Russian elite is excited about Skolkovo, a high-tech park-cum-enterprise-zone just outside Moscow. Skolkovo is supposed to act as a factory for indigenous technologists and entrepreneurs, a magnet for foreign multinationals, an inspiration for young people, an insurance policy against over-reliance on energy and a bridge between the scientific and the business worlds. Dubai contains a knowledge village, a media city, an IT corridor and a huge finance centre.

The downsides

Yet the odds on any of these efforts succeeding are low. Governments are good at providing the seedcorn for innovation: America's, for instance, provided some of the funding for Stanford University and even helped to found the first venture-capital company. But they are bad at turning seedcorn into bread. Josh Lerner, of Harvard Business School, describes state-sponsored innovation as a “boulevard of broken dreams”, a term more often applied to the entertainment industry. Malaysia's $150m BioValley, which opened in 2005, is now known as the “Valley of the Bio Ghosts”. Dubai has produced more red ink than new products. The architects of Skolkovo worry that Dmitry Medvedev's impending retirement from the presidency will doom their project before they have opened the first building.

Dan Breznitz and Michael Murphee, of the Georgia Institute of Technology, argue that the pursuit of indigenous innovation could prove to be a distraction. Foxconn, a huge Taiwanese-registered electronics group, has an unrivalled ability to mass-produce iPads and the like; it employs 270,000 people in its factory complex in Shenzhen. Huawei is a master of improving on other people's technology and bringing it to market at lightning speed. China's Pearl River delta is swimming with small companies that dominate tiny market niches. China's universities mass-produce graduates in disciplines that have been forgotten in the West, such as mining and heavy engineering. China would be better off exploiting these advantages rather than trying to build the next Silicon Valley.

Of productivity and power

There is striking evidence that state-owned companies are not only less innovative but also less productive than their private competitors. The Beijing-based Unirule Institute of Economics argues that, allowing for all the hidden subsidies such as free land, the average real return on equity for state-owned companies between 2001 and 2009 was -1.47%. Older studies suggest that productivity decreases with every step away from 100% private to 100% state-owned. An OECD paper in 2005 noted that the total factor productivity of private companies is twice that of state companies. And a study by the McKinsey Global Institute in the same year found that companies in which the state holds a minority stake are 70% more productive than wholly state-owned ones.

But poor productivity has not stopped them from making lots of money. In 2009 just two Chinese state-owned companies—China Mobile and China National Petroleum Corporation—made more profits ($33 billion) than China's 500 most profitable private companies combined. In 2010 the top 129 Chinese SOEs made estimated net profits of $151 billion, 50% more than the year before (in many cases helped by near-monopolies). In the first six months of 2010 China's four biggest state commercial banks made average profits of $211m a day.

State companies have been gobbling up private ones. They have also been gobbling up capital. State-owned companies in China pay interest of only 1.6% when they borrow from state banks, but private ones are charged 4.7%—if they can get a loan at all. In 2009 private firms accounted for only 2% of China's official outstanding loans. The result has been an epidemic of bankruptcies and suicides in the private sector even as state companies are splurging out on extravagant new headquarters.

Those state companies have a vast appetite for talent, too. Two Chinese with recent MBA degrees explain that they chose jobs with state-owned companies because they pay more than private ones and as much as multinational ones and offer shorter hours and cast-iron job security. But they were shocked by the extravagant perks and widespread corruption they found. A Russian who is currently studying for an MBA tells remarkably similar stories. The SOEs are recreating the old “iron rice bowl” (jobs and perks for life) with modern materials.

Yet there is little chance that state companies will be reformed soon. They provide comfortable berths for leading politicians and their children and hangers-on. Institutions that are nominally owned by the people have been taken over by ruling elites—the Communist Party in China, the security high command in Russia and the royal families in the Arab world. The 99% who do not benefit from these arrangements are getting increasingly angry with the 1% who do. But unlike their contemporaries in the West they have few ways of showing it.